In my original how to use sharesave SAYE schemes post I assumed that the changes made by my company to stop employees dropping share options that were underwater were universal.

They aren’t – some firms continue to allow employees to drop previous SAYE schemes and reallocate the dropped scheme’s allowance to the current year’s scheme, up to the HMRC £250 a month limit.

This was how my company used to do it, and I always took the line to drop the previous scheme and reallocate to the current one if the current offering’s option price was lower than the previous scheme.

I backtested the efficacy of this approach, compared to the rolling equal allocation I’d have to use now. Turns out the orginal gut feeling to drop was right. Tragically I always spread myself across the 3 and 5 years schemes, failing to appreciate how much better the 5 year schemes were, because of the longer time in the market. So going with my gut was overall only half right, a reminder that for those things that are amenable to analysis, there’s no substitute for doing the analysis, which is what I should have done in those dark days of DOS and Lotus 123, way back in the early 1990s…

No-brainer. Go for the 5 year scheme and drop underwater schemes. Note you should still test this with back-values from your employer’s specific share prices, sampled at the time of year your specific sharesave options are granted. This is using the FTSE100 as a proxy for the share price, and your industry may have peculiar cyclical patterns that just might make a difference.

It stacks up with my recollection. Feast in the barnstorming years of the late 1990s, mostly famine since then…

For this to be any use to you you need to be a worker drone in a company that is listed on the London Stock Exchange, and has a save as you earn scheme. In practice I think that means it’s probably a FTSE100 firm. If your firm doesn’t allow you to reallocate previous sharesave allocations before the term is due, the original How to Use Sharesave SAYE post is more relevant to you.

Most people do their new year review in January, and it’s still January, even if I’m nearly a month late. Last year I was looking for income, and this year I can look back, and conclude that I got it, to the tune of about 4% on the cost of what I put in. That’s possibly a minor fail as I target 5%, but I only have two-and-a-half year’s worth in my ISA and I buy throughout the year. So it’s possible that the ramp up across the year has something to do with that.

Perhaps I was a greedy b’stard as a teenager, but I did take the jobs market into account in deciding what I studied at university. For balance, I should also allow for a different world, one where science and technology were seen as making stuff happen, putting people on the moon, and the fading echo of Harold Wilson’t white heat of technology. So I was interested in science and later engineering, particularly electronics. This was a time when there seemed to be more hobbies involving people making things; I constructed my first audio system using many parts salvaged from skips where people were throwing out their old 26″ black and white TVs as they got rich enough to move to colour, even though it was on the back of the last double-dip recession the UK has experienced, in the mid 1970s.

At school there was the consideration of whether to go to university. At that time only about 7% of school leavers went to university, and I recall there being books with typical subjects and the sort of jobs that subject helped you into. I was academically capable enough and figured my choice was between electronic engineering and something wider, like Physics. I was totally unaware of any choices for university courses that weren’t part of the mainstream O and A level courses offered at school, which were English, Maths, Physics, Chemistry, Biology, French, German, History, Geography, Music and Art (though I don’t think the school did either of the last two at A level). I chose Physics rather than Electronic engineering because there seemed to be a wider range of jobs possible.

What puzzles me about what university students are increasingly studying is that it seems to be for specific things that offer little potential for employment.

If you consider the red line as the baseline (because the number of students was increased by 50% over the Labour administration), what are people really getting into? Nutrition, Journalism, Architecture, Drama, Philosophy, Politics, Marketing.

What are people really getting out of? Production and Manufacturing, American Studies, Agriculture, Sociology, Ophthalmics, French, Computer studies, Social Policy, Software Engineering. Science and Engineering of nearly all sorts is in retreat.

Now we are in a financial storm, and people need to find a load of money to go to university nowadays. What kind of jobs do Drama, Nutrition, Journalism set you up for? Newspapers across the country and shrinking,the Guardian seems to be going titsup, the theatre never makes money and the Arts Council has less taxpayer’s cash to flash around, and there are only so many nutritionists that Britain is going to need in a recession.

There’s more rationale for what people are getting out of. There’s no need for Production and Manufacturing in the UK unless you’re aiming for the high-end, and the sort of thing you needed Computer Studies and Software Engineering for are going to be done in India and eventually Africa.

There is far more information available to prospective students and their parents today, though there is also more uncertainty about what will be in demand in future. For all that, I’d expect people to be running away from what they’re getting in to, for the simple reason that it’s hard to see why people would spend a load of money studying for a dying field (journalism), or one that’s never made money ever (drama). Architecture and Marketing? maybe. The wholesale retreat from the sciences bodes ill for Making It In Great Britain as Saint Vince Cable would have us do. A double whammy for this project is demographics. There will be an awful lot of engineers and scientists from those white heat of technology days who will be quitting the workforce in the next 10 years. Hopefully that will mean opportunities in these fields but if graduates aren’t studying these subjects then those opportunities will go to waste and be exported. They may well be exported anyway, of course, if someone is looking for what to study they should perhap try and get a more accurate analysis of opportunities. The number of budding journalists looking to dive into a shrinking industry indicates this doesn’t happen, unless there is something I am seriously missing.

I’d never really taken the time out to analyse the different approaches to improving your financial situation, but MoneySaving Challenge did some of the the legwork came up with this intriguing summary

UK Personal Finance Blogosphere, Source: www.moneysavingchallenge.com

It’s reasonably obvious that frugality is at the opposite pole to consumerism, and indeed money management is also an antidote to consumerism. It did make me wonder, however, wherther frugality is a hazard to growing wealth. Although it’s a small sample, it indicates that British personal finance is sparser on the growing wealth axis than the American PF scene. Although the American Dream has taken a serious hit over the last few years, perhaps the myth of continuous progress is helping people in the States feel more chipper about their plight.

Perhaps that’s where I’m going wrong… There is also the implication that frugality is not necessarily the best way to growing wealth, and this is another notable difference with US perspectives, there tends to be a stronger bias to increasing your income rather than cutting spending. This wasn’t my experience; I only started to build significant financial assets after taking an axe to spending. For most of my working life I was building non-financial assets, in particular buying out my mortgage. Cost control worked for me.

I also observed an interesting gender distribution on the plot, let’s just say that the distribution does not appear to be gender-neutral to me. And that’s all I’m going to say on that front, but it is interesting what areas are focused on by the ladies and the guys 😉 For the sake of clarity, I don’t think this is because MSC imposed this distribution, I’ve observed it in the PF blogosphere as a whole.

For this to be any use to you you need to be a worker drone in a company that is listed on the London Stock Exchange, and has a save as you earn scheme. In practice I think that means it’s probably a FTSE100 firm.

The idea of sharesave is to encourage employees to take a share in the company, all considered A Good Thing. They’ve been running for years, I recall my Dad doing these. If your company offers one, they are a no brainer, do it, do it now, and do it to the max (£250 per month), as long as you don’t go into debt and have cleared your consumer debts other than mortgage. Once you have five year’s worth of contributions, you get that one way bet at no extra cost. It’s rude not to take part in an offer like that 😉

Caveat employer… don’t hold shares in your employer longer than you need to

You should generally avoid holding shares in your employer other than as part of sharesave or share incentive plan (another wheeze like SAYE, without the one way bet but with big tax advantages). That is because if your employer falls on hard times not only do your savings take a hit due to the share price bombing, but you are more likely to lose your job. The only exception I can think of is if you believe your employer is likely to be bought by another company, which is usually terrible news for employees but can be associated with a share price hike. It’s still a long shot and there are better ways of preparing for redundancy…

For a similar angle but from a bunch with more financial clout than me, see the FT on will you buy into the John Lewis economy on the hazards of over-exposure to your employer. Think Northern Rock when you fancy holding onto shares in your employer longer than you have to…

What’s so good about sharesave?

The reason sharesave is a no brainer is that it makes you the kind of offer you will never get anywhere else, a one-way bet on shares. The worst you can do is simply end up saving cash for three or five years.

What happens is in any year you are offered the option to buy shares in three or five years time at a price fixed at near what it is now. You start a monthly savings plan for up to £250 p.c.m. post-tax allocated in any proportion to the three and five year schemes. In five years time if the share price is higher than the option you exercise the option and then sell the shares immediately, pocketing the difference. Obviously if it’s lower you don’t exercise the option, and say I’ll have my cash back thank you very much, with some interest added usually. In a slightly depressing observation on the financial acumen of some of my workmates, I’ve known some people exercise the option when it isn’t in the money, and that’s even after the firm has added a letter to the maturity note saying you should note you can buy the shares cheaper on the open market. There’s no helping some people 😉

In the past it was easier because you were able to drop schemes where the option price was higher than the latest offering, but HMRC has stopped that wheeze, (No, they didn’t, just some accounting changes made it so letting employees do that cost the company. See this comment for details. If your company still allows you to drop a scheme and reallaocate the savings allocation to fresh schemes, then you want to read How to Use Sharesave Redux) so though you can drop a scheme you aren’t allowed to allocate that monthly allowance to later schemes until the original term is up. This means you need to think first before acting, to avoid stiffing yourself further down the line.

How to play sharesave to best advantage

First you need to ask yourself realistically how long you expect to be working for this firm. If it’s only for five years then buy the three year scheme for two successive years, £125 a month in year 1 and the same amount in year two (i.e. £250 in total in year two and three, then £125 in year four). However if you are looking at working there longer, then you need a plan.

Diversification is still your friend with sharesave, even though you are only dealing with one share. What everybody seems to miss, is that you have two temporal periods (3 and 5 years) and the chance to sample the share price every year.

What you don’t want to do is look at the option price for the two schemes in the first year, decide the 5 year scheme is cheapest, and lob your whole £250 savings into that. You want to maximise the diversity of your time-slots.

Diversify your temporal risk

You also want to maximise the amount of time you’re in the market, so if you are going to be a lifer in this firm (or even aim to work there for a decade) then buy £50 of the first year’s 5yr scheme, £50 of the next years 5yr scheme, and so on. After five years, your allowance for the first year’s scheme will come free as it matures, and you can allocate that to the sixth year’s SAYE scheme. If you sell as soon as your options mature, assuming they are in the money, then you will have the cash to allocate to your next allowance, so this one-way bet is now free.

You can do that instead with the three year scheme, but your options will only be in the market for three years rather than five, which reduces the amount of time your cash is in the market exposed to that one-way bet.

I simulated this using the FTSE 100 index as a proxy for a typical blue-chip firm offering a sharesave scheme.

yearly Sharesave returns if the company followed the FTSE100 index

and the cumulative profits over a 20 year period:

Cumulative sharesave profits over 20 years

The cumulative profits understate things because of inflation, and it also shows the heady profits that were to be had from the stock market in years gone by, the fat years after the early 90s recession up to the dot-com boom, then the 10 lean years from the dotcom bust to now…

The pattern is familiar, I made most of the money from sharesave in the years leading to the dot com boom, and very little in the decade after. Unfortunately there was corporate action for my employer in 2001 which means I can’t get a historical time series back to 1990. The ride was a bit more choppy than this graph shows, and sadly I didn’t realise that the 5 year schemes are so much more valuable than the three, so I did a mix of 3 and 5 years.

Watch out for specifics

The industry your employer is in doesn’t necessarily have the same statistics as the FTSE100. It’s likely to be a damn sight more choppy – I know my company is. So it may be worth simulating the last decade or so of price data for your firm. Here is the spreadsheet I used, exported to Google docs. There may be cyclical patterns in your company’s share price that make some of the assumptions break down. Having said that I’d have done fine running rolling five years sharesaves with my employer’s shares.

Don’t go with your gut

I learned something from writing this post. From a gut feeling, I had gone for diversifying the period, buying a mix of 3 and five year schemes. I had not realised until now the fact that the 5 year schemes give me more time in the market and how valuable that was.

This may have been offset by the fact that for my entire sharesave career I was able to drop previous schemes where the option price was higher, and reallocate the allowance to the more advantageous sharesave scheme. HMRC disallowed that in 2009, so you won’t be able to do that. Now if you take out a 5 year sharesave scheme even if you stop saving you can’t reallocate that allowance until the original 5 year term is up.

Responding to exceptional share price events

My employer had a near death experience which resulted in some pretty nasty management practices. Previously I had assumed I was going to carry on working to 60 at that time, but one particular incident showed me I was unlikely to make the course, so I switched all effort into saving up to be able to retire early. This near death experience slammed the share price in 2009, so the option price on that sharesave was very low. Though I didn’t know if I would still be working there in 2012, I dropped every single previous sharesave and threw everything into that year’s sharesave, with half the money allocated to the 3-year and half to the 5-year scheme. Obviously I have to put a lot more per month into the 3-year scheme as you only have 36 months to buy your shares, as opposed to 60 months. The aim is to have an equal monetary stake at the end. This works out to £94 in the 5-year and £156 in the three.

The principle is that you don’t know what will happen in 3 or 5 years time, so I want to bet on both horses. Say the Euro blows this year, then the 3 year options might lapse but the price on the option maturing may be lower. In that case don’t execute the option. There’s still chance for some of the storm to blow out and the 5-year option to come good. Although I don’t expect to be working there when the 5 matures, once the scheme has been running for three years then under some of the circumstances I may leave I could make it paid up.

If the 3 year option matured tomorrow, I would do very well out of this sharesave, indeed I couldn’t liquidate the shares without becoming liable for capital gains tax, which would be a first for me. I believe that the Euro is doomed beyond redemption, and that the denouement could very well happen this year.

So I have gone to IG Index and shorted half the number of shares I have options in. Barmy, you might say, why the hell short something I own, but that has the effect of locking in half the options at the current price. If they go down I make a profit at IG to compensate, if they go up I have to pay IG but I get more selling the options. I’m prepared to pay that as insurance. In three month’s time I will short half the remaining half, assuming it makes sense, to lock in the price for three quarters of the shares.

Spread betting comes with an extreme wealth warning, but it’s the right tool for the job here. Another case where you may want to short a stock you hold is to avoid eating a capital gains hit. Just carry on holding the shares and short them, buying the short and the number of shares you own / 100 (because IG prices move £1 for every penny the share price moves, with you rescale back but selling 1/100th of the amount). If nothing untoward happens I may have to do that in August; sell half the shares to avoid the CGT liability and roll over the IG short on half the total which I will still hold, eliminating my exposure to my employer without selling the entire stake.

Spread betting works for the tax-free employee share incentive plans too. With these, you buy up to £125 of shares from pre-tax and NI income, which you have to hold for five years before you can sell.

Sadly, this is another trick I missed, so some of the shares I hold went through the near-death experience, though they’ve come back up. I could have shorted thse guys as I bought them every month, taking the tax-free bump up and protecting my purchase against the vagaries of the stock market. However, it just goes to show one of the dirty little tricks of capitalism. By the time I got experienced enough to spot this insurance scheme, I’m about done with the opportunity to use it. As a colleague once wryly observed, money is drawn to money…

I was probably wrong – compound interest is all very well. Why it doesn’t work as well as people like to make out is that in your twenties you can’t put any decent amount of money into a pension, because of where you are in your financial lifecycle. You’re not earning much, so the basics of life are a higher proportion of your outgoings. And you’re starting out in life, so you aren’t as financially savvy as you may get, plus you have to buy lots of stuff to establish life as an independent adult. Merryn gets to the heart of the matter

We all think that we should start saving into our pensions from the moment our first paycheque hits. But it turns out that if we were “rational life-cycle financial planners”, we would wait until we are into our mid-thirties to save.

Everything we do financially should be to maximise our standard of living over our life cycles. In our early career years, when our earnings are low, we compromise our living standards if we save.

So we should consume our initial incomes and then step up savings as we earn more: with the percentage rising from zero before age 35, to 30-35% as we head towards 60.

Now I haven’t followed that exactly, but there has been a huge increase as I’ve got older. And as Merryn intimated, it gets so much easier to save as you get older, though with the caveat that having children and aspiring to help them with university costs can put the kibosh on that. Previous generations became financially independent of their parents as they came of age, making saving easier for the parents once they got into their 50s.

The takeaway isn’t that you should blow it all in your 20s – you should still be saving or building capital. Either in house equity if that is your bag, and you expect house prices to continue rising (why?) or in financial instruments to give you a passive income, which is equivalent to home ownership reducing your housing costs.

It’s hard to know the benefit of not having housing costs until you experience it. In my twenties I perpetrated the biggest misallocation of financial resources in my whole life by buying a house at the peak of the market, signing a mortgage document that was to be discharged in February 2014.

That screw-up was redeemed by paying down that mortgage about six years early. Not having to pay the mortgage means I can save much faster, for the simple reason that I need access to far less of my salary. Using salary sacrifice I can stop the Government stealing a lot of my pay, allowing me to save two year’s gross salary in three years by booting much of my salary into pension AVCs.

I don’t have to live on thin air 🙂 I live on an annual expenditure of less than the national minimum wage, but I have a standard of living that is much higher than you’d expect from that because I am using the accumulated capital from earlier years.

That is why compound interest doesn’t benefit me much in investment, I haven’t got the 40 years it takes to do anything useful at a 5% compounding rate – but that doesn’t greatly matter. I focused my investment as a young man in paying down my mortgage debt. That is still working for me – by dramatically lowering my costs so I can save and invest now.

Investing is a dangerous game, particularly for the young-ish and optimistic – I was slaughtered in the dot-com bust, largely from being too hot-headed and not knowing some of the ropes. You can get round some of that as a young investor by using passive investing, provided you start at a good time when equity market valuations are cheap. If you passively invested in the dot-com boom you’d still have been slaughtered in the last ten years, just not as quickly and perhaps not as comprehensively as I was. (edit – no you wouldn’t – see this comment for why)

Am I a better investor now? It’s impossible to know without looking 10 years ahead. I have better guidance, I have the learning from last time, and I am richer, so I won’t become a forced seller because I have more than half my non-pension savings as cash. I diversify by sector and to some extent by geography, though not financial asset-class, I’m either an equities guy or into non-financial assets. Well, apart from cash, I guess.

It surprises me that there’s so little said about life cycle financial planning. If you’re wealthy enough to be doing financial planning, you will probably experience a similar sort of life cycle. Yes, timing will be different for people who have children, but the arc of the life-cycle will still follow similar stages – you’ll probably be skint and capital-poor when young, you’ll be better off though probably with more dependents when middle-aged, then more capital rich but with a lower income when older. Saving 5% of my salary was a much bigger ask in my 20s than saving 70% of it in my 50s.

I was lucky in a lot of aspects, despite being hopelessly incompetent with the housing market. Rolling with my financial life cycle was probably one of those pieces of luck. I didn’t sit down to do it at 30, though some of it was instinctive in following the financial life-cycle of my parents, who discharged their mortgage when my Dad was in his late 40s, earlier than me.

Someone in their early 20s who takes Merryn Somerset Webb’s article and uses the information with self-knowledge, determination and persistence could do well by maximising their life-cycle standard of living. Of course, the need for self-knowledge, determination and persistence at 20 may be the rub. I struggled with the self knowledge, else I would have listened up and not bought a house at a market peak because I wanted out of the endless having to move because of other flatsharers’ life decisions.

There are few decent signals to be had in the stock market. If this report from the Investment Management Association is correct, then we’ve just had a good one.

Equity funds saw their largest outflow on record, with net outflows of £864 million in November, compared to a monthly average inflow of £506 million for the previous twelve months. Equity funds have seen net outflows in four of the last five months, following over two years of net inflows.

For the third month running, the highest selling asset class was Bonds, with net retail sales of £443 million, above the monthly average of £332 million for the previous twelve months.

Balanced funds were the second highest selling asset class when excluding the ‘Other’ category. Net retail sales of Balanced funds totalled £262 million in November, the lowest since April 2009 and well below the monthly average of £493 million for the previous twelve months.

The message is clear. Buy equities this year 🙂 I was so chuffed on reading this I caught up with my regular purchase of a FTAS and a global EM tracker funds which had gone astray over the Christmas break. As Warren Buffett said:

Be fearful when others are greedy, and be greedy when others are fearful.